In the first of many annual letters Chamath Palihapitiya will be penning as part of his firm’s new era as a technology holding company, the founder of Social Capital criticized the venture capital industry.
After highlighting the latest trends within VC — i.e. SoftBank’s Vision Fund, private equity activity in VC deals and inflated valuations — Palihapitiya divulged the asset class’s biggest problems. A copious amount of capital is flowing through the industry and VCs have an insatiable appetite for “unicorn status.” As a result, investors are paying more and more for equity in startups at all stages, hurting both startup employees and limited partners, who ultimately have to foot the bill.
“The dynamics we’ve entered is, in many ways, creating a dangerous, high stakes Ponzi scheme,” Palihapitiya, a former Facebook executive, wrote. “Highly marked up valuations, which should be a cost for VCs, have in fact become their key revenue driver. It lets them raise new funds and keep drawing fees.”
LPs and startup employees are suffering as a result of VC greed. Why? According to Palihapitiya, LPs are seeing delayed returns and startup employees are being offered stock options at inflated prices to match a company’s sky-high valuation.
“VCs bid up and mark up each other’s portfolio company valuations today, justifying high prices by pointing to today’s user growth and tomorrow’s network effects. Those companies then go spend that money on even more user growth, often in zero-sum competition with one another. Today’s limited partners are fine with the exercise in the short run, as it gives them the markups and projected returns that they need to keep their own bosses happy.”
“Ultimately, the bill gets handed to current and future LPs (many years down the road), and startup employees (who lack the means to do anything about the problem other than leave for a new company, and acquire a ‘portfolio’ of options.)”